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Accounting and Tax Tips Blog

What is a Real Estate Investment Trust?

A REIT, or Real Estate Investment Trust, is a company that owns or provides financing for income-producing real estate. Similar to mutual funds, REITs have shareholders and pay out taxable income as dividends. REITs enable ordinary investors to invest in portfolios of properties via the purchase of stocks. The majority of REITs are traded on major stock exchanges, however there are also public non-listed REITs and private REITs. REITs generally fall into two categories:

Equity REITs – These REITs generate income by the sale of and collection of rent on the properties that they own. As far as short-term rental REITs, there are an estimated 50,000 self-storage facilities in the United States. Self-storage REITs represent some of the country’s largest owners and operators of self-storage facilities and include:

  • Extra Space Storage Inc. (EXR)
  • Public Storage (PSA)
  • CubeSmart (CUBE)
  • Life Storage, Inc. (LSI)
  • National Storage Affiliates Trust (NSA)
  • Global Self Storage, Inc. (SELF)

Mortgage REITs – These REITs invest in mortgages or mortgage securities.

How to Form A REIT
REITs may own all different types of properties, including both residential and commercial real estate. To be considered as a REIT, as company must meet several criteria, including:

  • Investing at least 75 of its total assets in real estate
  • Earning at least 75 percent of its gross income from rents, mortgage interest from financing real property, or real estate sales
  • Paying at least 90 percent of its taxable income to shareholders in the form of dividends each year
  • Being considered as a corporation for taxation purposes. Sole proprietors can not form REITs.
  • Having a board of directors or trustees as the management for the company
  • Having at least 100 shareholders with no more than 50 percent of its shares held by five or less individuals

Costs of Setting Up a REIT

The costs to set up a REIT are substantial. Given that majority of REITs are multistate entities, the accounting work needed to set up a REIT is complex and the accounting fees can be around $500K just to form the REIT.

Are REITs Good or Bad for Airbnb/Short Term Rental Hosts?

According to the
WSJ, some large apartment REITs are in discussions with Airbnb about pursuing a revenue-sharing model with the company. These REITs, Equity Residential, AvalonBay Communities Inc. and Camden Property Trust are some of the largest apartment companies in the United States and the partnership would allow a larger portion of America’s housing stock to be rented as short-term rentals.

As a result, Airbnb hosts who have units in apartments that are managed by large REITs could benefit from such a partnership because they will no longer be disallowed from using Airbnb and can do so with the approval of the management company for the apartment. However, there are also some cons to the involvement of REITs in Airbnb’s business because it could mean additional fees for Airbnb hosts because the REITs may want a portion of the Airbnb host’s earnings to cover the cost of liability concerns that having short-term rental guests brings and because the REIT also wants to benefit financially from having Airbnb hosts rent out their units.

However, it is important to note that the impact of Airbnb is mostly felt by apartment REITs. That is because in most markets, Airbnb isn’t actually competing with hotels. Airbnb offers a niche service that is generally designed to work for leisure travelers looking for specific accommodations, not business travelers. In addition, the majority of Airbnb hosts are using the service to offset mortgage and rental costs in areas where leisure travel demand is high.

When to Begin Thinking About Forming a REIT

If you own a significant number of properties that you rent out on Airbnb and finding investors for your properties comes easy to you, it may be time to consider forming a REIT if you have already established a corporation for your real estate business. However, there are a number of
complex requirements for REITs, including organizational, operational, distribution and compliance requirements. You must also establish a board of managers or trustees as the management for your REIT.  

Forms to File

REITs are required to file Form 1120-REIT, U.S. Income Tax Return for Real Estate Investment Trusts in order to report their income, gains, losses, deductions, credits, certain penalties, and determine their tax liability. REITs are also subject to state corporate income taxes, as well as, local taxes.

Since REITs pay out their earnings in dividends, they are permitted to take a deduction for dividends paid (DPD) to their shareholders. Similarly, the corporate shareholders of the REIT claim a deduction for deduction for dividends received (DRD). The DPD and DRD generally eliminate federal tax liability for a REIT, which leaves the tax liability to its shareholders.

However, the differing state tax structures may not ensure that tax liability for a REIT is eliminated on the state and local levels. In addition certain states, including Maryland and Indiana have eliminated DPD in order to create state taxable income for REITs. As a result, the REIT may have tax liabilities in the states in which REIT property is located.

You should refer to the Multistate Tax Commission (MTC) website in order to determine which state and local taxes are applicable to your REIT.

Tax Filing Due Dates

Generally, a REIT is required to file Form 1120-REIT by the 15th day of the 3rd month after the end of its tax year. A new REIT filing a short period return, which is a tax return that is required when your REIT has not been in existence for an entire tax year, is typically required to file by the 15th day of the 3rd month after the short period ends. A REIT that has dissolved must generally file by the 15th day of the 3rd month after the date it dissolved.